While many organizations operate in the cross-border market, few mark foreign exchange volatility as the biggest threat to their profit margin; instead, pointing the finger to poor sales enablement, exuberant labor and machinery costs, or simply high competition. And while all of these factors can be costly, ignoring the clear threat of foreign currency volatility can be even more detrimental, especially in the current financial market.
Whether you’re part of a small family-owned business or running a large, multinational enterprise, managing both incoming and outgoing international payments can be a make-or-break task, especially if you don’t fully understand the changing landscape of foreign exchange transactions. With this in mind, we’ve put together a quick guide to help you identify the biggest myths surrounding foreign exchange for business and what you should really know.
Myths about Foreign Exchange
Whether you're a pro at foreign exchange or just getting started, it can sometimes be hard to distinguish fact from fiction when it comes to your global payments. Here are the most common myths in the forex market, so you can steer clear of the misconceptions and start making informed decisions.
Myth #1: I don’t have to worry about volatility.
The foreign exchange market is constantly fluctuating with currency demand driven by international trade, tourism levels, economic performance, and more. With all of these factors influencing exchange rates day-to-day, avoiding volatility in the market can be tricky.
At first glance, fluctuations in the currency market may seem small, moving only a mark or two at a time. But even these seemingly insignificant movements can have a serious impact on your firm’s bottom line and are often the cause of major variability in operating profit from year to year. In fact, according to one report, North American and European corporations suffered $9.54 billion in foreign exchange losses in Q2 of 2020 which was a 55% increase in losses from the previous quarter.
Taking a look at a quick example, imagine a US company is planning to purchase €10,000 worth of materials from a vendor in Europe. The contract states that payment for these supplies will be made once they are received in 90 days. Not understanding the true impact that currency volatility may have on their operating expenses, the US Company estimated its overall cost for these supplies based on the exchange rate at the time of agreement. However, when it comes time for the US Company to pay for the supplies received, the Euro has strengthened. Because of this, their overall costs for the materials have increased, pushing them above their budget for this purchase. Had this company better understood their exposure to market volatility, they could have taken out a forward contract, locking in the current exchange rate for their future payment – ultimately protecting their bottom line.
Myth #2: Risk management is expensive and only for large corporations.
Many assume that risk management is only reserved for the big players in the industry but that couldn’t be farther from the truth. Whether you're employing gig workers, simplifying your international supply chain, or opening overseas offices, any organization that operations in the cross-border market should have a foreign exchange risk management strategy in place.
With the assumption that hedging and risk management are reserved for large corporations comes the follow-up about expenses. Despite what some may believe, risk management strategies are a cost-effective way to protect your bottom line. Risk management hedging strategies can help protect your payments from poor market movements while also ensuring a more accurate projection of both cash flow and revenue – possibly saving you thousands in lost revenue from unplanned currency movements.
Myth #3: Learning to hedge is complicated.
If your firm interacts with foreign currency in any capacity then exposure to market fluctuations should be expected. This means that having a proactive risk management strategy in place should be a major consideration for leading executives. Regardless of the specific strategy, all hedging contracts act as a protection on your trade prices – an insurance policy of sorts to help minimize your foreign exchange risk resulting from unplanned market volatility.
At first glance, understanding the various hedging strategies available can be a nuisance with many firms ultimately concluding that hedging is far too complicated for their team. But that isn’t necessarily the case. Hedging contracts are designed to achieve specific foreign exchange and international payment goals based on your exposure to volatility and the desired protection that you may seek. In simplest terms, hedging strategies follow the nature of your business. If your business is fairly straightforward then you can expect your hedging strategy to reflect that same reality. However, if your business operations are a tad more complex then consulting a risk management specialist, who will take the time to research and understand the pertinent aspects of your business to construct a strategy that works for you, might be the way to go.
The Bottom Line
Whether you're just building up your international presence, or have been a player in the cross-border market for years, distinguishing fact from fiction when it comes to foreign exchange risk management can be a tricky process. That being said, taking the time to understand the detrimental effects currency volatility can have on your firm’s bottom line is essential to remaining competitive in the ever-changing landscape of global operations.
Not sure where to start? Speak to a member of our dedicated foreign exchange specialist team to learn more about creating a tailor-made risk management strategy today.